Common Triggers for Cannabis Audits
IRS examinations of cannabis businesses frequently focus on the size and composition of cost of goods sold relative to industry norms, given that COGS is the primary deduction mechanism remaining under 280E. State-level reviews in New Jersey more commonly address sales tax remittance, Social Equity Excise Fee calculations, and, since the 2023 decoupling legislation, whether expenses deducted for state Corporation Business Tax purposes are properly documented as ordinary and necessary.
Our Audit Representation Process
We handle all correspondence with the examining agency directly where possible, prepare the documentation package supporting your reported positions, and represent you in meetings or calls with the examiner. Where positions are challenged, we evaluate whether to negotiate, provide additional support, or pursue formal appeal, based on the strength of the underlying facts and documentation.
- Direct correspondence and representation with IRS or New Jersey examiners
- Reconstruction and organization of COGS support documentation
- Metrc data reconciliation to support inventory positions
- Appeals coordination when positions are initially challenged
Preparing Before an Audit Notice Arrives
The strongest audit defense is built before an examination begins, through contemporaneous documentation of cost allocation methodology, consistent Metrc-to-ledger reconciliation, and clean bookkeeping records. Clients who engage us for ongoing accounting and tax planning enter any subsequent audit in a materially stronger position than those who reconstruct records after receiving a notice.
State Corporation Business Tax Reviews
Because New Jersey's 280E decoupling is relatively recent, state examiners are paying close attention to how licensed cannabis businesses substantiate the ordinary and necessary business expenses they deduct at the state level, making thorough contemporaneous documentation particularly important for CBT filings.
What an IRS examiner requests first in a 280E cannabis audit
Federal examinations of New Jersey cannabis operators typically open with an information document request for the general ledger detail behind COGS, the Metrc inventory reports for the audit period, and any cost-allocation study or methodology memo supporting how indirect production costs were capitalized under 263A. Examiners increasingly cross-reference the Metrc plant and package counts against the taxpayer's reported production volume, so a mismatch between Metrc-reported harvest weights and the units used in the COGS calculation is one of the first things flagged.
We prepare clients for this by assembling the workpaper package before an audit is ever opened: a written cost-allocation methodology, the underlying labor time studies or square-footage allocations, a reconciliation tying Metrc quantities to the inventory sub-ledger for each month of the year under exam, and copies of the destruction manifests supporting any inventory losses claimed. Having this assembled proactively — rather than reconstructed under a 30-day IDR deadline — is consistently the difference between an exam that closes with minor adjustments and one that expands into multiple years.
Responding to a CRC compliance inquiry versus an IRS examination
A CRC compliance review focuses on operational and licensing conformity — Metrc discrepancies, security and packaging requirements, municipal transfer tax remittance, and social-equity or diversity plan adherence — and generally requires a faster, more narrative response tied to specific regulatory citations rather than a full financial reconstruction. An IRS 280E examination, by contrast, is a financial and documentary exercise focused entirely on substantiating the COGS calculation and testing whether disallowed expenses were properly excluded.
The two can intersect: a Metrc discrepancy flagged in a CRC compliance review (an unreconciled transfer manifest, an unexplained inventory variance) can become exhibit material in a later IRS examination if the taxpayer's inventory records were never cleaned up. We treat every CRC compliance finding as a signal to also review the corresponding federal COGS support, because regulators and examiners are increasingly looking at the same underlying Metrc data from different angles.
- Assemble cost-allocation methodology memos and time studies before an exam, not during one
- Reconcile Metrc quantities to the inventory sub-ledger for every month under examination
- Treat unresolved CRC compliance findings as a prompt to review related federal COGS support
